Capital ideas but Turner ducks the tricky issues

Lord Turner's review just about lived up to its billing as a revolutionary document. But how could it not? The past regulatory regime had failed so completely to foresee, let alone prevent, the banking crisis that credible reform had to involve a rush in the opposite direction.

Turner's big ideas were welcome and obvious. Banks will be forced to hold more capital against their trading position to reduce leverage and improve liquidity. Markets are no longer assumed to be rational, so financial institutions will be forced to set aside capital to enable them to ride the inevitable booms and busts - they must act as shock absorbers, rather than shock amplifiers, as Turner put it.

Similar thinking is extended to pay and bonuses. Remuneration schemes that are perceived as risky must be backed by more capital - a belated recognition by the Financial Services Authority that high rewards and high risks go hand in hand. The FSA will feel freer to intervene in the affairs of foreign banks operating in the UK; after the disastrous invasion of Icelandic banks, that idea was a no-brainer.

So far, so good. The heaviest weapon the FSA could deploy was capital adequacy and Turner has used it well. Capital is a language banks understand. It forces them to make sober calculations about risk and it changes behaviour: Turner is probably correct in believing that some of the absurdly complex financial instruments will disappear as they are made more expensive to manufacture. There will be squeals that the FSA is undermining the competitiveness of the City, but they can be ignored for now. In the new world of banking, a commitment to sobriety may act as good advertising for London; we shall have to wait and see.

So why did the report also feel under-whelming? It was because Turner ducked two big issues and in another contentious area - the separation of casino-style investment banking from utility banking - he took the soft option.

The first issue he ducked was the regulation of financial products, specifically mortgages. Should there be a ban on 100% loan-to-value loans? What is an acceptable loan-to-income ratio? Turner promises an assessment later this year. It's no wonder he's confused. Ever the technocrat, he seems to be searching for a mechanical formula. Common sense says the answer must, in part, involve the exercise of good judgment on the ground, which is the way mortgages used to be granted. How secure is an individual's employment prospects? What is their credit history? These considerations can't be reflected in catch-all mathematical models.

On "macro-prudential regulation" - the identification of risks building up in the system - Turner was vague about how the FSA and the Bank of England would co-operate better. Maybe he was simply obeying orders, since Gordon Brown is not about to sanction a radical overhaul of the tripartite system of financial regulation he created. At some point, though, flesh will have to be put on the bones.

Then there was Turner's rejection of a new Glass-Steagall act - the idea of separating "utility" banking from "casino" investment banking. The governor of the Bank of England wants to encourage a debate on the subject; Turner seems to want to close down discussion. "It is certainly not possible to separate casino banking so completely that we can happily let it go bankrupt in crisis," Turner says.

But, come on, tolerating a situation in which a deposit-taking bank can lose a fortune in the casino and then expect a state rescue is absurd. It encourages bad behaviour. Relying on Turner and his successors to patrol the floor of the casino perfectly is asking for trouble. Creating cleaner lines between different forms of banking would seem to be an essential way of building firewalls into the system; it's feeble to say the task is too tricky. The bottom line? File the Turner review under work-in-progress.

Guilt-free gilt policy

Yesterday the US Federal Reserve hit the panic button. The printing presses rolled - $300bn will be spent on long-term government securities and a further $850bn on bits of paper issued by the mortgage lenders Fannie Mae and Freddie Mac. The message is clear: the US will do whatever it takes to revive its economy, including a debasement of its currency.

The effect on the dollar was electric - it plunged against the euro and the yen. Life for the export-led economies of Germany and Japan is about to get harder. Viewed from the eurozone or Tokyo, the US is indulging in a beggar-thy-neighbour devaluation, knowing that the hands of the European Central Bank are tied since the Germans are hardly likely to sanction the purchase of IOUs issued in Greece. Next month's G20 meeting will be explosive.